The FTSE 100 has been on an impressive run these past few months, even reaching new record highs. Yet despite this upward momentum, not every investor is optimistic. In fact, several analysts are expecting a stock market crash later this year.
Dr Michael Bury, an ex-hedge fund manager that predicted the 2008 Financial Crisis, and GMO founder Jeremy Grantham have both made bold predictions about a looming crash in 2023. And if their thesis is accurate, then stocks could be set to plummet in the coming months.
Of course, this doomsday forecast is far from confirmed. And the group of bearish investors may be wrong, with shares set to continue climbing as economic conditions improve. But let’s assume the worst-case scenario. What can investors do to protect their portfolios and capitalise on any looming volatility?
Preparing for a crash
A golden rule in investing is never to buy shares with money needed within the next three-five years. Why? Because when periods of short-term volatility inevitably materialise, investors don’t want to be in a position where they are forced to sell at terrible prices.
As crazy as it sounds, often the best move during a stock market crash is actually to do nothing. Long-term investors have the luxury of time. And given sufficient time, a high-quality business will likely recover from economic turmoil before reaching new heights, taking the share price with it.
Selling shares to mitigate losses is akin to trying to time the market, which is practically impossible. All too often, an investor will sell shares only to watch them rise a few weeks later.
Even if a stock continues to plummet, most investors are late when repurchasing shares, resulting in substantial opportunity costs during the recovery period. It’s worth remembering that the best returns are generated during stock market recoveries.
This is also why it’s crucial to have some capital saved up. During a crash, panicking investors have a habit of selling off anything with a pulse. And even the best businesses in the world, unaffected by the catalysts behind the market downturn, can see their stock prices plummet.
By ensuring a lump of money is ready, brave investors can capitalise on these bargains, bolstering their existing positions, or opening new ones at discounted prices.
Investing during volatility
Buying top-notch shares during a stock market crash can unlock substantial market-beating returns in the long run. But this strategy is far from risk-free. During market turmoil, investment decisions are primarily based on emotional reactions rather than rational thinking.
Therefore, an investor who has identified a terrific business trading at a dirt-cheap price may still watch the valuation drop even further. That’s why drip-feeding spare capital into the markets, instead of investing it all in one go, is more sensible.
That way, if prices continue to tumble, the investor can capitalise on the discounted valuation even more, bringing their average cost basis down while pushing their long-term return up.
Of course, that’s assuming the underlying business meets long-term performance expectations, which can never be guaranteed. Hence, diversification also plays a critical role in risk management during a stock market crash.
